Paper claims
July 13, 2021
–New high SPX and Nasdaq on a light volume day. Yields edged slightly higher with tens ending at 1.363%. CPI today expected +0.5 month/month and 4.9% year over year. Core expected 4.0% from 3.8 last. Yesterday the NY Fed released consumer expectations of inflation at 4.8%, up from 4.0% at the last survey. All of which points to solid demand at today’s 30 year auction which was sporting a w/i yield of NEARLY 2% yesterday afternoon. Why does the market accept a negative real return of a few percent on long treasuries? Because of the Fed backstop. Perhaps Powell will have a different take on it as he gives semi-annual Congressional testimony tomorrow.
–As a preview to tomorrow’s congressional questioning: There’s an amusing op-ed rant in the Guardian by someone named Hamilton Nolan that addresses the wealth gap in the US. He sets his piece up by focusing on the Sun Valley conference. “Here, America’s wealthiest mega-billionaires gather with the chief executives of America’s most powerful companies, the director of the CIA, and America’s most worthless pseudo-journalists (hello, Anderson Cooper) to develop the social and business connections that allow the top 0.00001% of earners to continue to accumulate a share of our nation’s wealth that already exceeds the famously cartoonish inequality of the Gilded Age of Rockefeller and Carnegie.” Not a single mention of the contribution of the Fed’s and the Biden administration’s stimulus measures that have turbo-powered stocks and real estate. Mr. Nolan’s solution? Put them in jail. Quite thoughtful.
–A friend posted a tweet yesterday from LeoNidasThisISSparta (I could not find the original tweet) who said he took 1 silver contract into expiration and was promised delivery June 15th, delayed to June 22, then pushed back to June 29, then to July 1. They (I suppose he means the exchange) continually offered to cash-settle, which he finally accepted. His conclusion, “I bet no one is actually getting silver delivered.” I have a suspicion that the physical commodity, no matter what it is, is likely to become much more sought after than the derivative. I’ll be keeping an eye on Dec soybean oil, now near 64 vs a high of 66.67 in June.
Bond yield rebounding slightly this a.m.
July 9, 2021
–Yields continued to fall yesterday with tens down 3.2 bps at futures settlement to 1.289%. Fives were the leader, falling 4.5 to a yield of just 73.7 bps. On the euro$ curve greens (3rd year) were the strongest, closing +8.0. However, the curve steepened quite a bit from there, with golds (5th year) up only 3.375. 2/10 notched a marginal new low at 110.
–Three month libor neared the all-time record low, setting at 11.9 bps yesterday. The BBG bank funding index BSBY set at 10.098 bps; the spread of 1.8 is quite narrow compared to what it has been (more like 4 to 5 bps) suggesting that libor has a good chance to rebound higher.
–Though there has been significant position liquidation in euro$ puts, there is some buying shifting to March midcurves: 2EH 9825p settle 6.0, buyer of 12k, and 3EH 9800p settled 9.75, buyer of 20k for 9.5 yesterday.
–A couple of related, or perhaps not, pieces of news yesterday. Wells Fargo is closing all existing Personal Lines of Credit, apparently related to previous transgressions. (Could it also mean that the end of rent moratoriums are going to lead to bankruptcies?) Also, Consumer Credit was released for May, and it showed a whopping $35 billion increase, $9b in credit cards and $26b in non-revolving autos and student debt, the latter category being up at a 9.5% annual rate. I suppose if I had the chance, I would tap the student loan pool, as the new administration will be ever more tempted to forgive it all (it’s for the children). The auto loans probably can’t last at the same blistering pace. People are starting to return slowly to public transit. The end of WFH is showing up in things like shelter dogs being returned to shelters. JOLTS data shows a remarkable amount of job openings, just one more piece of data that doesn’t quite square with the stunning bond rally of late.–Reuters reports that China cut its RRR (reserve requirement ratio). “…releasing around 1 trillion yuan in long term liquidity to help underpin an economic recovery that is starting to lose momentum.” They said it will help small firms deal with the impact of the surprising rise in commodity markets.
Stocks reversing
July 8, 2021
–Stocks in a sharp reversal this morning with ES -56, Nasdaq -190 and RTY -38. Interest rate futures continue to rally after yesterday’s 4.7 bp drop in tens to 1.32%. New low once again in 2/10 which fell just over 4 bps to 110.7. Whether sparked by China’s continued clampdown on big tech and hints of rate cuts, or renewed covid fears, US yields are telegraphing that growth and inflation have already peaked and are headed for a hard skid. Of course, the Fed minutes did NOT make that forecast. The staff report was positive on growth prospects as least through the end of the year, though saw risks tilted toward the downside due to the possibility of covid variants. They saw inflation risks balanced citing upside risks related to bottlenecks and a possible change in inflation expectations, and trotted out the (now discredited) flat Phillips curve for the downside. Interestingly, ‘participants’ saw balanced risks on growth, but inflation risks tilted to the upside due to labor shortages and bottlenecks which might persist.
–Big trade +2EU1 9900/9875ps vs -3EU 9850/9825ps 0.5 paid for 40k, buying green. EDU3 settled 9909.5 and EDU4 9868. so 9.5 out vs 18.0 out. The actual calendar settled 41.5 versus 50 between top strikes. Implied vol firmed significantly in treasuries, indicating that fear has shifted to the prospect of a continued rally.
FOMC minutes today
July 7, 2021
–FOMC minutes today will perhaps give a better sense of taper timing as yields continued to fall yesterday. Tens down over 6 bps to just 1.368%. 2/10 treasury spread made a new low of 115, down 4.6 on the day. Red/gold (2nd to 5th year euro$ spread) now equals 2/10, settling at 114.75, down over 6 on the day. This spread began June just over 162 bps. The gold pack (5th year) soared 9.5 bps with a price just over 98.33, a yield just below 1.67%. What is notable is that the red/green pack spread (EDU2, Z2, H3, M3 vs EDU3, Z3, H4, M4) is 57.625. So that one-year spread is almost exactly half of the three-year red/gold spread. The elevated premium is partially due to the libor transition date at the end of 2023, but it also reflects a rough idea that 2 hikes could occur at the end of next year going into 2023, and then tail off from there. Perhaps the idea is that a split midterm election will close the fiscal purse at the same time that the Fed is becoming less generous. Another notable feature of yesterday is that the ten year inflation-indexed note is nearing negative 1% again, closing at -97.6, down 5.6 bps on the day. The Fed claims to have some concerns about frothy real estate prices, but rock bottom mortgage rates along with deeply negative real rates suggests continued flows into real assets like homes and gold.
–EDZ2/EDZ4 spread traded 118 just after the FOMC meeting. Settled yesterday at 97. There was a buyer of ~15k 3EU 9887.5c yesterday, which settled 4.75 vs underlying EDU’24 9864.5. If we get near that strike, then Z2/Z4 will likely be 80 to 85. Worth noting is that a significant amount of activity yesterday was short covering in that open interest was down across the board. Open Interest in ED, -62k, in TU -21k, in FV -42k, TY +3k, UXY +0.8k and US -1.6k.
Big Oil
July 6, 2021
–It’s all about oil this morning as the OPEC meeting disintegrated. CLQ1 currently 76.50, up 1.34. I’ve attached a chart which shows that a long term trendline off the 2008 high has been violated, though technical details probably aren’t all that important in the current environment. A BBG article this morning notes the Dec’21/Dec’22 Brent spread in deep backwardation, and says the last time it was here was 2011 to 2014, when oil was around $100/bbl. CLZ1/CLZ2 is currently 7.31 with the front contract at a premium (backwardated). Of course, that’s often an argument for ‘transitory’: temporary shortages now will give way to more reasonable prices in the future. Perhaps so, but CLZ1 is around 72.50, and the 100 calls on that contract are now 0.35/0.37 with over 20k in open interest; they were around 25 cents the last time I has looked. I can’t help but recall the somewhat famous line by Dennis Gartman in January 2016, “In my lifetime, we will not see $40 crude oil again for longer than a week.” Of course, if you Google $100 oil, you can find many forecasts of that level with one notable one in 2017 by Goldman. With the market shunning productive investment in fossil fuels in favor of “green” technologies, it shouldn’t be a surprise that oil has the possibility of strength well into the future. What it means for rate policies is an open question, though the RBA took a baby step in trimming QE from $5b A$ per week to $4b. In the US, what the man in the street will see is higher gas prices, with government officials reassuringly saying that inflation is not a problem.
–There’s an amusing interview with Charlie Munger where he praises the Chinese authorities for shutting down Jack Ma and his attempts to expand into the sphere of banking. Currently, China is putting a heavy hand on Didi due to data violations. (I suppose the breach is that the data is supposed to flow directly to the central government). In any case, it’s a somewhat interesting contrast between China’s crackdowns on the largest companies and the new US antitrust chief, 32 year old Lina Khan, famous for her articles on monopolistic practices, especially those of Amazon. The famous antitrust action was back in 1911 when Standard Oil was broken up (just to bring it back to our initial topic). Now it’s not big oil, it’s big data. From an Atlantic article fawning over Khan: “When a company has such power, Khan believes, it will almost inevitably wield that power far and wide, distorting not just the market itself, but the whole of American life. With sufficient power, companies can commission studies, rewrite regulations, bulldoze neighborhoods, and impoverish education welfare systems by securing billions in sweetheart tax cuts.” [I couldn’t resist using this quote, because I suspect the slant is much more of the Atlantic author’s than Ms Khan’s. That’s just the way it is. Better to go to Khan’s source material of course. “We cannot cognize the potential harms to
competition posed by Amazon’s dominance if we measure competition primarily through price
and output.” I for one, wish her well in stopping the abuses of the social media system, but again, I suspect she is up against forces that require more authoritarian power than she could ever hope to wield].
–In spite of Zoltan Pozsar’s warning about possible shifts in funds related to the recent increase in the RRP rate that could cause higher short end funding costs and possibly spill over into longer dated assets, rate futures are building slightly on Friday’s strength. Just look at the oil curve. It’s transitory.
https://www.agriculture.com/news/business/crude-oil-will-not-stay-above-40-again_5-ar52205
https://www.theatlantic.com/magazine/archive/2018/07/lina-khan-antitrust/561743/
https://digitalcommons.law.yale.edu/cgi/viewcontent.cgi?article=5785&context=ylj
Stop Making Sense
July 2, 2021
–NFP expected 716k with yoy Avg Hourly Wage +3.6% from +2.0 last. It doesn’t seem to matter to fixed income, as stocks power to new highs and oil trades above $75/bbl, the high since 2018. This period (mid 2018) was when data was strong following Trump’s tax cut package, and the Fed was tightening – what they used to refer to as “taking away the punchbowl”. Different from today, when they’re pouring in grain alcohol and making sure there’s plenty of weed for the non-drinkers. As of this morning, USU trades 160-29, the bearish price action from Wednesday afternoon into yesterday morning has been erased with prices testing Wednesday’s high of 160-31. Though today’s data could change things, my bearish outlook didn’t pan out and I would have to cut the short position.
–Oddly, the eurodollar curve is telling a slightly different story. The peak one-year calendar is EDU’22/EDU’23, which settled at a new high of 65.5. The market appears to expect Fed hikes that will snuff out any embers of lingering inflationary expectations. Current inflation is obvious, but I suppose it’s a story of skating to where the puck is going to be, not where it is now. I just think they’re skating in the wrong direction. Given the SOFR transition at the end of June 2023, the Sept 22/23 spread is probably indicating two rate hikes. A cleaner reflection of Fed hike expectation is Jan’22/Jan’23 FF spread, which settled 27.5, so at least one Fed move is priced for that period.
–Deep in-the-money call buying in eurodollars: 18k EDZ2 9900c for 56.5, settled 55.75 vs 9946, 5k EDH3 9775c for 164, settled 163.25 vs 9934, and 5k EDM3 9775c for 153, settled 151.75 vs 9919. From open interest prelim, appears to be new buying of 75 to 90 delta calls. Just one more trade that doesn’t seem to make much sense….but I am getting used to that by now.
–Beware of thin conditions this afternoon as the holiday weekend starts. Happy 4th!!
Sanctimonious preaching
July 1, 2021
–Markit Mfg PMI for the euro zone hit a record 63.4. Today in the US, ISM Mfg is expected 61.0 from 61.2 last. Jobless Claims are expected 388k. The attached chart shows ISM Mfg Prices pinned towards historic highs at 88. Going into tomorrow’s payroll report, ADP was released yesterday at 692k, but the previous number was revised lower so it was about a wash relative to expectations. Corn and beans soared on the crop report, with Dec Corn +40 cents and trading about 6 higher this morning at 595. In addition, CLQ1 made a new high of 74.55 bbl this morning.
–If quarter end was marked exactly at 4:00pm EST then the last gasp of bond buying occurred just prior to that with a print in USU of 160-28. From there it immediately sold off and is 160-00 this morning. Price action suggests to me that the buying fever has broken; I would be inclined to place a short with a stop just above yesterday’s highs and an initial target around the mid-June low of 157-12. Of course, tomorrow’s data could prove volatile, but might not matter all that much given the technical set up. The ten year yield was down 3.4 at futures settle at 1.444%, but is now again above 1.47. A popular trade in eurodollars, EDZ’22 to EDZ’24 two-year calendar, settled at 102.5, but immediately popped back up to 105 late in the session yesterday. New recent low in red/gold euro$ pack spread at 120.375 as reds (2nd year) closed +1 and golds (5th year) were +4.0.
–There was a new buyer of 10k TYU 135/136 call spread yesterday, which settled 5/64 vs TYU 132-16. It got a bit of BBG press as a trade targeting 1% in tens. My guess is that it’s a protection trade, and the buyer will be delighted to lose those 5/64’s and see the market go the other way, as a sacrifice to the bond gods.
–China’s leader Xi decried “sanctimonious preaching” alluding to the US in his speech marking the 100 year anniversary of the China Communist Party. Of course, I can’t side with Xi on much of anything, but on the topic of sanctimonious preaching he’s on to something, because it’s out of hand in the news media and across special interest groups. On the other hand, his uncompromising vow to re-incorporate Taiwan is unsettling, if not unexpected.
Russian hacks spark reflation!
June 30, 2021
Little change in yields Tuesday, with tens unch’d at 1.478% as we head into payrolls on Friday. We get a hint with ADP this morning, expected at 600k. There is also a grain report, with futures trading slightly soft currently (Where in the hell is Beeks?). One trade of note was a buyer of EDZ2/EDZ4 at a price of 105 (settled 104.5, 99.47 vs 9842.5). Several large clips of this two-year calendar trade have gone through as Morgan Stanley reportedly recommended it. The FT reports today that several hedge funds were burned on reflation trades by the hawkish FOMC. Pretty obvious by price action, which has now probably run its course if the mainstream financial press is highlighting it.
–At 4:00 a.m. EST something appears to have spooked equity futures, with one colleague pointing to comments from ECB’s Panetta that the delta variant is outweighing confidence in global growth. Some also point to a Bild story about a major Russian hack attack on German banking infrastructure. There is a slight bid in US treasuries, though there was some notable buying in US puts late, including 2k of US week-1 (expires Friday) 158p for 5/64’s. On the FOMC release, the contract traded 157-12. In tens there was buying of Week-1 131.5p (settled 2) and in Week-2 a buyer of 15k 130.5/130ps for 2. Again, markets will be thin on Friday afternoon going into the holiday weekend, but the CME, in its wisdom, remains electronically open until 5pm EST.
–On a more granular level, a friend tells of a small US manufacturer of steel specialty cables. This business has been running flat out due to strong demand, but a hack in the past week caused a halt to operations. This is a recurrent theme that takes time and money to protect against. It is an increased input cost across business that is rarely mentioned in the ‘reflation’ story, and judging by news reports, is not transient.
Lower yields
June 29, 2021
–Quiet session Monday which featured new highs in Nasdaq and SPX along with falling bond yields. TYU1 settled 132-08+ with a cash yield of 1.478%, well above the data release on Friday which showed Core yoy PCE prices +3.4% (TYU around 132-04 at the time). Interest rate futures continue to shake off bearish news as we go into Friday’s payroll report. In dollars, there was a new buyer of 20k EDZ2/EDZ4 calendar at 106.5 to 107. The spread settled 104.5. Trade appears to be an add to purchases made just after the FOMC, when the price was 118. Just over 100 bps for a two year period when growth and inflation are buoyant seems quite low, but that’s the theme of US rate markets. Red/gold euro$ pack spread (2nd year to 5th year) fell just over 3 bps to 124. From 2004 to 2006 the Fed hiked at every single FOMC, 200 bps per year. Markets are currently hard pressed to see anything more than 50 bps in a given year.
–Neel Kashkari has a piece in the FT with the title “Banks cannot expect government to bail them out of every crisis. (they must increase their equity funding to protect against the next unexpected shock).” Almost by definition, the entire financial system is bailed out of all “unexpected” shocks. That’s why the Fed runs reassuring stress tests to allow for share buybacks and dividend increases. The real question, yet to be answered, is if the next unexpected shock will be a direct consequence of the unprecedented magnitude of the covid bailout.
Transitory Intermediation*
Weekly comment – June 27, 2021
On Tuesday, Cleveland Fed President Loretta Mester gave a speech on monetary policy and financial stability. On Thursday, the Fed released its report that the banking system had passed stress tests without a problem. Here is a quote from Mester:
There are several avenues through which the use of nonconventional monetary policy might create or contribute to financial system vulnerabilities. A commitment to a protracted period of very low interest rates could encourage risk-taking as investors search for yield; it could lead to a build-up in leverage; and it could lead lenders to lower their credit standards and promote increased borrowing. While all of these are avenues through which monetary policy typically affects the economy, the concern is that these effects could be excessive and create or contribute to financial vulnerabilities.
We have record high stocks, a booming housing market, shortages of skilled labor, the lowest junk bond yields ever and a ten year yield that can’t seem to hold much above 1.5%. A BBG article notes a record amount of IPOs in the first half of 2021 of $350 billion, exceeding the previous record of $282b in the second half of last year. Any excesses here? You just might be on to something Loretta. From Thursday’s green light for bank buybacks: “The Federal Reserve Board on Thursday released the results of its annual bank stress tests, which showed that large banks continue to have strong capital levels and could continue lending to households and businesses during a severe recession.” I suppose that’s why the Fed had to create at least eight emergency lending facilities and Special Purpose Vehicles for COVID.
The Fed is so confident about the resiliency of the banking system and the US economy that they’re afraid to taper and move rates from zero. Of course, they would still have to check with Larry Fink first.
Later in her speech Mester mentions, “Nonbank financial intermediation, through investment funds, insurance companies, pension funds…has risen over time. These entities now hold almost half of global financial assets up from 42 pct in 2008. This means that credit risk is increasingly being intermediated and held outside the banking sector.”
It’s pretty easy to conclude there’s froth in markets. BBG has another weekend piece discussing a pivot from “Peak Central Bank Support” and notes Bank of Mexico’s surprise rate hike last week and China’s continuing efforts to control debt. Obviously the Fed is making some small steps in that direction, and the market has responded by moving up the timing of rate hikes. As an example, the peak one-year Eurodollar calendar spread is now EDU’22/EDU’23 at 64 bps. The highest one-yr spread settlement of this cycle has been EDM’23/EDM’24 which settled 78 on April 5. It’s not really the case that this latter spread reflected an expectation of three 25 bp hikes, and that’s because of the libor cessation at the end of June 2023. Spreads that encompass that event are higher due to the transition to SOFR. However, for this rough analysis, it doesn’t matter. The point is that since the April 5 high of 78, EDM’23/EDM’24 has tailed off to 59, while EDU’22/EDU’23 is only 4.5 bps off its high settle of 68.5 on April 2. Let’s look at a few spreads since the beginning of April, when they were at the highs. I’ll use December contracts, since the Fed’s FOMC projections are end-of-year. (Table below)
Near one-year spreads aren’t at the peak, but they are at new highs for the year. EDZ’21/Z’22 is now 33.5, having started the year at 5.0. The next spread is EDZ2/Z3 which again, covers the libor transition, but it’s down 10 from the high of 71.5 in April. EDZ3/Z4 has tumbled 21.5 bps, with about ten of that coming after the FOMC meeting.
| EDZ1/Z2 | EDZ2/Z3 | EDZ3/Z4 | EDZ4/Z5 | |
| 2-Apr-21 | 28.0 | 71.5 | 65.0 | 40.5 |
| 25-Jun-21 | 33.5 | 61.5 | 43.5 | 25.5 |
| change | 5.5 | -10.0 | -21.5 | -15.0 |
One could make the argument that these spreads paint the case for Powell’s transitory inflation argument, in that the flattening of the back half of the curve is because expected inflation by that time will be lower than now. However, the corollary is that the market perceives lower future inflation because the Fed will be tightening sooner. For example, Rosengren said conditions for a hike by the end of next year could be in place soon, echoing other officials. Now it’s all about data and a slow-play by the Fed.
These spreads tell you about market perceptions of hikes both by levels and direction. New highs in near spreads suggest the end of next year is lift-off. I had thought the market might be more forceful in making the point that the Fed was ‘behind the curve’, and that’s why I’ve favored buying short Dec midcurve put spreads with EDZ’22 as the underlying. Example, 0EZ 9937.5/9912.5ps settled 5.25 Friday but was around 3 the previous week. Because of the dynamics between inflation and possible Fed actions, I have leaned more towards simply buying back month puts rather than forecast timing with futures spreads. I like blue midcurve puts (on EDU’24, EDZ’24, EDH’25) because I think inflation data will continue to worsen over the next few months, but that Powell will continue to play it down.
*And what does transitory intermediation mean? Nothing. Just sounds good.
Now for a detour into current affairs. A huge fossilized skull was found in China, possibly representing a new branch of the family tree. He’s been dubbed ‘Dragon Man’. From The Guardian: “The skull, which is 23cm long and more than 15cm wide, is substantially larger than a modern human’s and has ample room… for a modern human brain. Beneath the thick brow ridge, the face has large square eye sockets, but is delicate despite its size. “This guy had a huge head” said Stringer.
There was a broker on the trading floor, (and anyone who worked on the floor knows what’s coming next) who had a substantial head. The question, which was somewhat more worthy of serious consideration than other hypotheticals, was, “Would you rather have this guy’s head full of nickels, or a million dollars?” If Dragon Man had been discovered in those days, a broker would have sent a runner out to go buy a taper measure… “and make sure it has centimeters on it.”
OTHER MARKET THOUGHTS/TRADES
On Wednesday we have ADP, on Thursday ISM Mfg and on Friday, the employment report. Nonfarms are expected 700k which would be the highest level of the year excluding the March release of 785k. The CME has a full electronic session and a half day on Monday. Given a somewhat bearish response to Friday’s PCE price data, I think robust payroll numbers could really stick a fork in the bond market, especially in a thinly traded afternoon when most people leave early for holiday plans. I would consider buying week-2 (July 9th) US 155p for 5/64’s, which is where they settled vs 158-54. The low in the contract in May was 153-29, though the front June contract low at the time was 155-14. There is a minor trendline that come in around 156-00. This isn’t about targeting a particular level, it’s about the chance of a higher than expected number blowing up the market in thin conditions.
| 6/18/2021 | 6/25/2021 | chg | ||
| UST 2Y | 25.8 | 26.8 | 1.0 | |
| UST 5Y | 88.9 | 92.9 | 4.0 | |
| UST 10Y | 145.3 | 153.4 | 8.1 | |
| UST 30Y | 202.5 | 217.0 | 14.5 | |
| GERM 2Y | -66.6 | -64.7 | 1.9 | |
| GERM 10Y | -20.0 | -15.5 | 4.5 | |
| JPN 30Y | 67.4 | 67.4 | 0.0 | |
| CHINA 10Y | 314.2 | 309.8 | -4.4 | |
| EURO$ U1/U2 | 24.0 | 24.5 | 0.5 | |
| EURO$ U2/U3 | 61.5 | 64.0 | 2.5 | |
| EURO$ U3/U4 | 44.0 | 47.5 | 3.5 | |
| EUR | 118.64 | 119.38 | 0.74 | |
| CRUDE (active) | 71.29 | 74.05 | 2.76 | |
| SPX | 4166.45 | 4280.70 | 114.25 | 2.7% |
| VIX | 20.70 | 15.62 | -5.08 | |
